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By Giorgio Ferrero

Daily Data: Caterpillar (CAT)

I just wrote about Caterpillar on Wednesday, April 18, but I'm genuinely interested in the stock, which I've been waiting to pull the trigger on buying. This weekend, I went further into the fundamentals of the company and found that CAT is trading at 0.83 PEG ratio. The PEG ratio is something that I did not cover in my previous articles on CAT, which strengthens the argument for buying the stock. As of last Friday, CAT's P/E ratio was 14.56. Quarter 1 earnings are expected to be announced before market hours on April 25, 2012. The estimates are 2.33/2.127/1.83 (High/Mean/Low). Caterpillar reported 1.84 EPS for the first quarter of last year. If CAT reports 1.84 for the quarter on Wednesday morning then the TTM EPS number of 7.40 will not change. Based on CAT's forecasted 5-year EPS growth rate of 17.50% the stock will be valued at $129.50 (7.40*17.50) if the stock reports around its low estimate of 1.84.

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My hunch says Caterpillar will not report in the low estimates since markets have continued to recover since this time last year. I have spoken to employees who work for distribution centers that send out spare parts for Caterpillar machinery, they tell me the spare parts are constantly sold out! Apart from the fact that Caterpillar is undervalued on a fundamental basis technically the stock is trading just around my estimated max low right now!

Given that CAT closed at $107.73 last Friday the stock is trading below my estimated max low for May'18th based on historical returns between March to May option expiration.

Suggested Trade:

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Option Trade: CAT - Sell May'18th 97.50/95 put spread (Bull Put Spread)

(Sell 97.50 Put/Buy 95 Put)

Size - 10% of Option Spread Portfolio Size = (4 spreads)

Entry: Sell Limit: 0.25

Stop Loss: 0.50

Exit Price: 0.00

Max Return: 11.11%

(Max Return Calculated on Return on Risk from my entry, not Return on Margin)

Daily Data: Apple (AAPL)

I was certainly wrong placing bull put spreads on AAPL during the starts of its massive uptrend. Had I taken off these spreads sooner when we had a profit, the option portfolio would be in a better place right now. However, given that AAPL has proven its technical superiority and fabulous earnings the stock is undervalued at a 0.90 PEG ratio. Apple is set to report Q2 earnings after market hours on April 24, 2012. The estimates are 11.80/10.001/8.46 (High/Mean/Low) we all know that Apple consistently outperforms estimates. However, if the stock were to report what it did this time last year (EPS: 6.4), which is completely below the current low estimate of 8.46, the stock would still be worth $640.25 (TTM earnings is 35.11*5-year growth rate of 18.22%). Now that we know Apple stock is fundamentally undervalued let's see technically how it's traded from March to May option expiration.

Above we see that AAPL's estimated max low for May'18 is $511.78. We also see that AAPL declined only twice during this period (we can hardly count the -0.20% return as a decline), thus it has been bullish during this period. Based on the stock's recent short-term downtrend I feel comfortable selling something far out of the money as I bet investors will hold the stock at the 50 SMA at least before earnings.

Suggested Trade:

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Option Trade: AAPL - Sell May'18th 500/495 put spread (Bull Put Spread)

(Sell 500 Put/Buy 495 Put)

Size - 10% of Option Spread Portfolio Size = (2 spreads)

Entry: Sell Limit: 0.55

Stop Loss: 1.30

Exit Price: 0.00

Max Return: 12.35%

(Max Return Calculated on Return on Risk from my entry, not Return on Margin)

Daily Data: Union Pacific Corporation (UNP)

Union Pacific just reported and beat both EPS and revenue estimates last Thursday. Consequently the stock has traded neutral to bearish since its earnings report. The CEO Jim Young said "Looking ahead, we expect continued slow but steady economic growth in 2012. The diversity of our unique railroad franchise will continue to provide growth opportunities in various markets. As we move into the 150th year of Union Pacific, our prospects have never looked better." The company sounds like it has its head on it shoulders and reported great. Fundamentally the PEG ratio on UNP is 1.00 so investors looking at its P/E see that its inline with the 5yr future EPS growth rate. What investors may not know is that UNP is trading near my estimated max low for Mar-May option expiration.

Above we see the UNP has historically rallied during March-May option expiration. The stock just closed at $107.26 last Friday, which puts it very close to my estimated max low of $104.09 for May'18. If UNP will hold its $107 uptrend line then I suggest the following trade:

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Option Trade: UNP - Sell May'18th 100/97.50 put spread (Bull Put Spread)

(Sell 100 Put/Buy 97.50 Put)

Size - 7.5% of Option Spread Portfolio Size = (3 spreads)

Entry: Sell Limit: 0.30

Stop Loss: 0.80

Exit Price: 0.00

Max Return: 13.63%

(Max Return Calculated on Return on Risk from my entry, not Return on Margin)

Option Spread Portfolio Current Positions:

CVS Caremark (CVS) (May'18 42/41 Bull Put Spread): We've come close to our stop out on CVS before but now given the bullish close on the stock last Friday we looking good again in this position.

Direxion Daily Financial Bear (FAZ) (May'18 19/20/21/22 Reverse Iron Condor): In order to make the potential full amount in this position, one leg of the reverse iron condor must expire fully in the money Currently this position is doing well as the May'18 21/22 bull call spread is fully in-the-money.

DIRECTV (DTV) (May'18 47/46 Bull Put Spread) - Since we've entered Direct TV the stock has continued to trade at a 0.90 PEG ratio. The stock may be in a holding period around $48 until its earnings on May 7th.

Baxter (BAX) (May'18 57.50/50 Bear Call Spread) - We're probably going to exit our position in Baxter early this week. Since the FDA announced that it was going to ask additional questions on Baxter's joint HyQ Biologics License Application the stock has gapped down. The company reported and beat both EPS and revenue estimates on Thursday but the market has not taken notice. Since the stock still trades at a 1.56 5yr PEG ratio ((P/E)/ (5-year Earnings Per Shares Growth)) then the market is going to remain neutral to bearish this stock which does not coincide with my neutral to bullish position. After speaking with Baxter I have learned that it will probably take months before the air is cleared with the FDA questioning.


Charts and fundamental analytics are from finviz.com, tradingeconoimcs.com, and e*Trade.com

Source: The Reasons These 3 Companies Are Attractive